SERVICE CLASSIFIES UNIT INVESTMENT TRUSTS AS GRANTOR TRUSTS.

Index Nos.: 7701.03-05, 0676.01-00, 0671.02-00, 0243.00-00, UIL Number(s) 0116.00-00

March 1, 1982

Refer Reply to: T:I:I:2:1

B proposes to create C, a series of unit investment trusts, under the laws of the state of X. Each unit investment trust will be created by the execution of a separate trust indenture and agreement by B and a trustee. Each trust will be formed with the objective of appreciation of capital for investors.

The portfolio of each trust will consist of substantially equal dollar amounts of r common stocks or other securities convertible into such common stocks (the underlying securities). These securities will be selected by use of the monthly valuation, determined by an evaluation program owned by B, which next precedes the five business day period beginning on the date of the prospectus (the Portfolio Assembly Period). The securities will consist of the u securities most recently determined by the evaluation program to be the most "undervalued" in each of the v industries selected as the most "undervalued" by the evaluation program's methodology.

The methodology consists of analyzing the income and balance sheet data of the companies studied and mathematically relating this historical information to the projected earnings outlook for each company and the current market price of its stock as measured by its price/earnings ratio. More than s companies in t industry groups are evaluated.

In the event of a departure from the top u selections, the stock rated as the next most undervalued within the same industry group, which has not otherwise been selected for that particular trust, will be substituted, and so on as necessary. If no additional security purchases can be made from the same industry group, then the most undervalued issue in the zth most undervalued industry group will be purchased, and so on as necessary.

During the Portfolio Assembly Period, investors will have the opportunity to buy units of undivided interest in the particular trust from B for a price of w dollars per unit. B will retain x of the w dollars as a sales and portfolio brokerage charge and will deliver the remaining y dollars to the trustee.

The funds received from B as a result of the sale of the units in each trust will be used by the respective trustee to pay for its trust's underlying securities. Funds received from B and not immediately used to pay for securities will be deposited in interest-bearing or demand bank accounts or used to purchase certificates of deposit maturing before needed payment for the underlying securities, which according to market practice should be no later than five business days after the last day of the Portfolio Assembly Period.

Section 2.03 of each Trust Indenture and Agreement (the Indenture) provides that voting rights with respect to the underlying securities held by the Trust shall be exercised by the trustee as directed by the Depositor.

Section 3.02 of the Indenture provides, in part, that the trustee may not invest either income or the proceeds of sale of any underlying security. However, the trustee will deposit such monies in interest bearing or demand United States bank accounts or use the monies to acquire certificates of deposit maturing before the distribution date.

Section 3.03 of the Indenture provides, in part, that the trustee may set aside such amounts as it, in its sole discretion, shall deem requisite to establish a reserve for any applicable taxes or other governmental charges that may be payable out of the Trust.

Section 3.07 of the Indenture provides, in part, that the Depositor may direct the trustee to dispose of underlying securities upon the occurrence of certain following events: (a) there has been a significant decline in the index of an underlying security's relative value as determined by the *** stock evaluation method or other market or credit factors have occurred such that in the opinion of the Depositor there is a serious question as to the fundamental economic liability of the issuer; or (b) there has been a failure of the issuer to declare or pay an anticipated dividend, or (c) an action or proceeding has been instituted in law or equity seeking to restrain or enjoin the payment of dividends on any such security.

Section 3.08 of the Indenture provides, in part, that in the event that an offer shall be made by an issuer of any of the securities to issue new securities in exchange and substitution for any issue of securities held by the Trust, or in the event that any tender offer is made for any underlying security, the Depositor shall instruct the trustee to accept or reject such offer; provided however that the Trust may not convert any convertible securities in its portfolio. In the absence of instructions from the Depositor, the trustee shall reject the offer made by any such issuer except in the case of stock dividends or stock splits, where the trustee shall accept the new securities.

Section 5.02 of the Indenture provides, in part, that the Depositor shall, upon request by the trustee, provide the trustee with a current list of securities designated to be sold for the purpose of redemption of units tendered for redemption.

Section 5.03 of the Indenture provides, in part, that certificates issued pursuant to this Indenture are interchangeable for one or more certificates in an equal aggregate number of units.

Section 7.02 of the Indenture provides, in part, that a certificate-holder may at any time tender his certificate or certificates to the trustee for redemption.

Section 9.04 of the Indenture provides, in part, that the Trust shall terminate upon the redemption, sale, or other disposition of the last security held hereunder, unless sooner terminated as previously specified in this Indenture, rpovided that the Trust shall in no event continue beyond the Mandatory Termination Date.

The Mandatory Termination Date is defined in section 1.01(9) of the Indenture to mean 15 months after the last day of the Portfolio Assembly Period.

Section 301.7701 - 4(a) of the Procedure and Administration Regulations provides that generally an arrangement will be treated as a trust if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.

Section 301.7701 - 4(c) of the regulations provides that an "investment" trust of the type commonly known as a management trust is an association, and a trust of the type commonly known as a fixed investment trust is an association if there is power under the trust agreement to vary the investment of the certificate holders. See Commissioner v. North American Bond Trust, 122 F.2d 545 (2d Cir. 1941), cert. denied, 314 U.S. 701 (1942). However, if there is no power under the trust agreement to vary the investment of the certificate holders, such fixed investment trust shall be classified as a trust.

In Rev. Rul. 73-460, 1973 - 2 C.B. 425, a corporate stock brokerage firm (firm) executed a trust agreement with a bank (trustee). Firm deposited with trustee certain interest-bearing municipal obligations, contracts for the purchase of such obligations, and the cash required for such purchases. Trustee delivered to firm all of the units in the trust. Firm, in turn, sold all the units to investor clients.

The trust was to terminate upon the maturity, redemption, sale or other disposition of the last obligation held unless sooner terminated as provided in the trust agreement. In no event was the trust to continue beyond January 1, 2010.

In order to preserve the sound investment character of the trust, firm was to direct trustee to sell obligations, provided firm had determined that the existence of certain conditions specifically set out in the trust agreement such as default in the payment of principal or interest on obligations or a substantial decline in the market value of the obligations.

Trustee was authorized under the trust agreement to withdraw from cash on deposit such amounts as it deemed necessary to establish a reserve for any applicable taxes or other governmental charges that may be payable out of the funds of the trust.

In the event that an offer was made by an obligor to issue new obligations in exchange and substitution for any issue of obligations, the firm was to instruct trustee to reject such offer and either to hold or sell such obligations, except that if (1) the issuer is in default with respect to such obligations or (2) in the opinion of firm, the issuer will probably default with respect to such bonds in the reasonably foreseeable future, firm was to instruct trustee to accept or reject such offer or take any other action with respect thereto.

The Service found that under the terms of the trust agreement, firm and trustee did not have the power to reinvest moneys in additional obligations or to vary the investment of the certificate holders. Accordingly, the Service concluded that the trust was a fixed investment trust and qualified as a trust under section 301.7701 - 4(c) of the regulations.

The trust in Rev. Rul. 75-192, 1975 - 1 C.B. 384, also was found not to be an association taxable as a corporation, but rather a trust for federal income tax purposes. The trust assets were FHA and VA mortgages. The trustee made quarterly distributions of all principal and interest payments received to each investor in proportion to his interest therein. Between distribution dates, the trustee was required to invest cash on hand in short-term obligations of (or guaranteed by) the United States, or any agency or instrumentality thereof, and in certificates of deposit of any bank or trust company having a minimum stated surplus and capital. The trustee was permitted to invest only in obligations maturing prior to the next distribution date and was required to hold such obligation until maturity. All the proceeds received from the mortgage payments along with the interest earned on these short-term investments and deposits were to be distributed to the investors quarterly. The trustee had no authority under the trust agreement to purchase new securities or mortgages or to make any other investments. The Service held that the trustee was limited to a fixed return similar to that earned on a bank account and thus, any opportunity to profit from market fluctuations was eliminated.

In Rev. Rul. 78-149, 1978 - 1 C.B. 448, the Service stated that the existence of a power to sell trust assets does not give rise to a power to vary the investment. Rather, it is the ability to substitute new investments, the power to reinvest, that requires an investment trust to be classified as an association. See Pennsylvania Co. for Insurances on Lives and Granting Annuities v. United States, 146 F.2d 392 (3rd Cir. 1944).

The savings and loan association (association) in Rev. Rul. 70-545, 1970 - 2 C.B. 7, established a pool of mortgages which were insured by the Federal Housing Administration and the Farmers Home Administration. Each of the mortgages in the pool bore interest at the rate of 8 1/2 percent per annum. Once the pool was established no additional mortgages were permitted to be added to the pool. The Association received a commitment from the Government National Mortgage Association (GNMA) to guarantee an issue of "fully-modified pass-through mortgage-back certificates." Neither GNMA nor the Association had any power to reinvest any of the proceeds attributable to the mortgages in the pool. Association arranged for the sale of the entire issue of mortgage-backed certificates to various certificate holders. The mortgage-backed certificates called for payment by Association to the certificate holders of specified monthly installments. The Service concluded that this pool should be classified as a trust and that the certificate holders should be treated as the owners of the trust under subpart E, subchapter J, chapter 1, subtitle A of the Internal Revenue Code.

In Rev. Rul. 72-137, 1972 - 1 C.B. 101, a liquidating trust was established by a corporation for the purpose of receiving real property which the corporation had been unable to sell, selling the property, maintaining and collecting the income from the property prior to sale, collecting the proceeds of sale and distributing to beneficiary-shareholders the net income and proceeds of the property. This transaction was recast by the Service as a distribution by the corporation of the real property to its shareholders followed by a transfer in trust by them of the real property. Based on this recasting, the Service then concluded that the trust should be classified as a trust for federal income tax purposes under subpart E, subchapter J, chapter 1, subtitle A of the Code.

The sponsor of the fixed investment trust and other similar trusts in Rev. Rul. 81-238, 1981 - 41 I.R.B. 12, adopted an automatic reinvestment plan, which allows certificate holders to make further investments of income and principal distributions from the trusts. Shortly before each distribution date the sponsor would cause the creation of a new fixed investment trust in which the certificate holders in the existing trusts could invest their distributions. A bank is designated to receive trust distributions on behalf of those certificate holders who elect to participate. The bank combined the distributions and purchased certificates of beneficial interest in the new trust. Prior to the adoption of the automatic reinvestment plan, the fixed investment trust was classified as a trust rather than an association taxable as a corporation, and it was a grantor trust of which the holders of the trust units were considered pro rata owners for federal income tax purposes. The Service concluded that the classification of the trust as a trust for federal income tax purposes was not terminated by the adoption of the automatic reinvestment plan.

Section 671 of the Code provides the general rule that in cases where the grantor or another person is regarded as the owner of any portion of a trust, there shall be included in computing his taxable income and credits, those items of income, deductions, and credits against tax of the trust which are attributable to that portion of the trust (to the extent that such items could be taken into account in computing the taxable income or credit against the tax of an individual).

Section 676(a) of the Code provides that the grantor shall be treated as the owner of any portion of a trust, whether or not he is treated as such owner under any other provision of subpart E, where at any time the power to revest in the grantor title to such portion is exercisable by the grantor or a nonadverse party, or both. An exception to section 676(a) is made when the power to revoke is not exercisable until after the expiration of 10 years.

Section 1.671 - 2(c) of the Income Tax Regulations provides that an item of income, deduction, or credit included in computing the taxable income and credits of a grantor or another person under section 671 of the Code is treated as if it had been received or paid directly by the grantor or other person (whether or not an individual). For example, a charitable contribution made by a trust which is attributed to the grantor (an individual) under sections 671 through 677 will be aggregated with his other charitable contributions to determine their deductibility under the limitations of section 170(b)(1).

Section 1.671 - 4 of the regulations provides that items of income, deduction, and credit attributable to any portion of a trust which, under the provisions of subpart E (section 671 and following) are treated as owned by the grantor or another person should not be reported by the trust on Form 1041, but should be shown on a separate statement to be attached to that form.

In Rev. Rul. 77-349, 1977 - 2 C.B. 20, X, a bank, pursuant to a pooling agreement formed a pool of residential mortgage loans by assigning such loans to Y, an unrelated bank, serving as trustee of the pool. Concurrent with the assignment of the loans, Y delivered to X certificates of interest in the pool. The certificates were eventually resold to investors. For the duration of the pool neither X nor Y were empowered to invest proceeds attributable to the mortgages in the pool. Similarly, neither was empowered to substitute new mortgages for the original ones in the pool. Some of the federal income tax consequences that flowed from this transaction were the following: (1) the pool was classified as a trust of which the certificate holders were the owners under subpart E of subchapter J of the Code; (2) Y was the trustee of a grantor trust and was required to file Form 1041; (3) each certificate holder was treated as the owner of an undivided interest in the entire trust (corpus as well as ordinary income); (4) the sale of the mortgage-backed certificates transfers to the certificate holders the pro rata share of their equitable ownership of each of the mortgages in the pool; (5) each certificate holder using the cash receipts and disbursements method of accounting shall take into account its pro rata share of the mortgage interest and other items of income as and when they are collected by X; and (6) each certificate holder using an accrual method of accounting shall take into account the pro rata share of the mortgage interest and other items of income as they become due to X.

The facts in Rev. Rul. 70-545, 1970 - 2 C.B. 7, are similar to those in Rev. Rul. 77-349. In Rev. Rul. 70-545, though, the Service added as an additional tax consequence of the transaction that the certificate holders must report their ratable share of the entire interest income on the mortgages as ordinary income consistent with their method of accounting.

In reporting dividend income each certificate holder should be mindful of sections 116 and 243 of the Code. Section 116 provides that for tax years commencing after December 31, 1980, and before January 1, 1982, gross income for individuals does not include the sum of the amounts received during the year as a dividend from a domestic corporation or interest. However, the aggregate amount excluded for any taxable year for such items of income shall not exceed $200 ($400 in the case of a joint return). Section 243(a) provides, in part, that in the case of a corporation there shall be allowed as a deduction an amount equal to 85 percent of the amount received as dividends from a domestic corporation which is subject to taxation under chapter 1 of the Code.

Section 1001 of the Code provides that the gain from the sale or other disposition of property shall be the excess of the amount realized over the adjusted basis provided in section 1011 for determining gain. The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.

Section 1011 of the Code provides that the basis for determining the gain or loss from the sale or other disposition of property shall be the basis determined under section 1012 of the Code. Section 1012 provides that the basis of such property shall be the cost of such property.

Section 1222 of the Code defines short-term and long-term capital gains and losses by reference to whether the asset sold or exchanged is a capital asset.

Section 1221 of the Code defines the term capital asset as property held by the taxpayer (whether or not connected with his trade or business) other than property falling within the scope of any of six categories of property excluded from the definition of a capital asset. The only category of excluded property which is relevant to this case is described in section 1221(1) as "stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of the taxpayer's trade or business."

A taxpayer will be considered to hold securities for sale to customers within the meaning of section 1221(1) of the Code only if the taxpayer acts as a dealer with respect to those securities rather than a trader. Kemon v. Commissioner, 16 T.C. 1026 (1951), acq., 1951 - 2 C.B. 3.

The holding period under section 1223 of the Code begins on the day after an asset is purchased or the benefits and burdens of ownership are assumed by the purchaser. See Rev. Rul. 54-607, 1954 - 2 C.B. 177. Since a purchase by a grantor trust is considered as a purchase by each grantor (to the extent of his undivided interest), the holding period of a grantor in his undivided interest in a security will begin the day after the purchase of the security by the trust. However, a grantor who purchases an interest in a trust after the trust's acquisition of the assets will have a holding period in each asset that commences on the date the interest in the trust was purchased. Cf. Rev. Rul. 67-309, 1967 - 2 C.B. 235.

Based on the information submitted and representations made, we conclude as follows:

Each trust is to be classified as a fixed investment trust. Since there is no power to vary the investment in any of the trusts, each is to be treated as a trust for federal income tax purposes. The unit holders, however, should be regarded as the settlors of the respective trusts. Since the settlors of each trust are also its beneficiaries, each trust should be treated as a grantor trust under subpart E, subchapter J, chapter 1, subtitle A of the Code.

As a grantor trust, the trustee of each will be required to file annually Form 1041, with all items of income, deduction and income attributable to the settlor-beneficiaries of each trust shown on a separate statement attached to the form. Section 1.671 - 4(a) of the regulations.

Under section 676 of the Code, each unit holder will be treated as the owner of an undivided interest in the entire trust (corpus as well as ordinary income).

Under section 671 of the Code each unit holder in computing his taxable income shall take into account his pro rata share of dividends received by the trust in which he has an interest.

Each unit holder using the cash receipts and disbursements method of accounting shall take into account his pro rata share of interest and proceeds of sale of trust assets as and when they are collected by the trust in which he has an interest. Rev. Rul. 77-349.

Each unit holder using an accrual method of accounting shall take into account his pro rata share of interest and proceeds of sale of trust assets as the trust in which he has an interest acquires a fixed right to receive them. Rev. Rul. 77-349.

Each unit holder shall take into account a pro rata share of the trust's deductions against tax in accordance with the unit holder's method of accounting. Rev. Rul. 70-545.

With respect to taxable years of unit holders commencing after December 31, 1980, and before January 1, 1982, each individual unit holder's pro rata share of dividends and interest will be eligible for the $200 combined interest and dividend received exclusion for individuals and trusts ($400 in the case of a joint return filed by a husband and wife), provided that the interest and dividends are from sources which qualify for the exclusion under section 116 of the Code.

Each corporate unit holder's pro rata share of dividends received by the trust will be treated as if directly received by the unit holder, and accordingly, will qualify for the 85 percent dividends received deduction under section 243 of the Code for corporations to the same extent as if the unit holder had received such dividends with respect to stock held directly by such unit holder.

Each unit holder who is not a dealer with respect to the securities held by the trust will be treated as having capital gain or loss, as appropriate, whenever the trust sells an underlying security.

The gain or loss realized by each unit holder on the trust's disposition of a trust asset shall be computed by measuring the unit holder's aliquot share of the total proceeds from the transaction against the unit holder's undivided interest in the disposed asset.

A unit holder's basis for the undivided interest in any asset disposed of by the trust attributable to a unit shall be the adjusted basis for that unit at the time of the disposition multiplied by a fraction the numerator of which is the fair market value (at the valuation date nearest the date on which he purchased the unit) of the asset disposed, and the denominator of which is the sum of (i) the fair market value (at the valuation date nearest the date on which he purchased the unit) of all the underlying securities on hand at the time of disposition, and (ii) the amount of the trust's cash, certificates of deposit and savings accounts at that time.

In addition to the basis a unit holder has in each security possessed by the trust, he shall receive a basis in his aliquot share of sale proceeds, dividends and interest received by the trust, which is equal to the gross amount of his aliquot share of such proceeds, dividends and interest.

At the time the trust disposes of an underlying security, a unit holder's holding period for the undivided interest in that underlying security will begin the day after the later of the trust's purchase of that security or the unit holder's purchase of his unit, and will end on the day of the trust's disposition of that security.

The sale, exchange or redemption of a unit by the unit holder shall be treated as a sale or exchange of the unit holder's undivided interest in the assets of the trust at the time of the transaction. To the extent gain or loss recognized on such transaction is attributable to a security held by the trust, such gain or loss will be capital gain or loss provided that the unit holder is not a dealer with respect to such security. The amount of gain or loss will be equal to the difference between the proceeds attributable to such security and his basis in his undivided interest in such security.

Except as specifically ruled upon above, no opinion is expressed as to the federal income tax consequences of the proposed transaction under any other provision of the Code.

This ruling is directed to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.

A copy of this ruling should be attached to the first return filed for the trust. A copy is enclosed for that purpose.

Sincerely yours,